What's the True Rate of Inflation?

2011 - 2015

We don't really have an answer to that question. You can look at the BLS inflation calculator, but that's based on the Consumer Price Index, and the true rate of inflation may not be found in the CPI or other government measures.

In his book Bad Money, Kevin Phillips explains how inflation data has been manipulated in various ways, in order to show a lower rate. This may have been done in large part to reduce federal outlays for cost-of-living increases in Social Security. New rules for computing the Consumer Price Index, or CPI, were put into place starting in 1997.

For example, the old standard of a fixed basket of goods was eliminated in favor of a flexible approach that took into account "substitution bias," which, it was claimed, had made inflation appear higher than it really was. The idea that if the price of juice goes up, people's cost of living doesn't go up by an equal amount, since many will just substitute a cheaper alternative, like sugary drinks. If aluminum prices rise, you can buy tin pans, so your personal cost of living doesn't rise much. Using this principle, things that are going up in price are now given less weight in the index - precisely because they are going up.

Some of us find this to be strange logic for computing the level of prices.

In addition, there were now "hedonic" adjustments for product quality. This is based on the theory that even if your cable television costs more, you are getting more channels, and hence more pleasure for your money. Therefore, the reasoning goes, we can't apply the entire cost increase of many products and services to calculating the CPI, since we're not getting the same products or services, but something better. Of course, this conveniently ignores the fact that you often don't have the option to get the previous lower-quality product or service at the previously lower price. In other words, you may not have the option to get the cheaper less-comprehensive cable service.

For a more dramatic example, consider that computer monitors went from $40 to $160 when the change to flat screens was complete, without the option to buy the boxy $40 types once they were no longer sold (although it is true that many of the flat screens have come down to the $100 range since then).

At the extreme it could be said that if computer prices were unchanged, but the computing power doubled, then your cost of computer power dropped in half. Of course you cannot buy half of a computer, nor can you necessarily make it do twice as much work for you, just because it has twice the power. But in 2003 the government did try to reduce the "real" price of computers (as opposed to what you actually pay) used in computing the CPI, based on the increased satisfaction consumers presumably get from newer models. They dropped this part of their calculations after a critical letter from the National Science Foundation's Committee on National Statistics.

Critics of the changes in calculating the CPI point out that now, we no longer measure a constant standard of living (which, we should admit, is difficult to do in any case). They say that we may now be measuring the cost of maintaining a declining standard of living. After all, if people have to substitute less-desired products for those that become too expensive, they may spend the same amount, but their standard of living has certainly declined according to their personal values. If we all buy white bread when whole wheat becomes too pricey, it can be said that our grocery expenditures are the same--or even less--but our diet and health are not up to the same standards as before.

Another trick is in the measuring of housing costs. Housing makes up 40% of the CPI, so this is a crucial part of the inflation picture as represented in government statistics. It should be handled very carefully, yet the government doesn't even look at the actual costs of owning a home. They use a shortcut called the "owners equivalent rent." This is what the owner-occupant could get if they rented out their house.

This way of measuring costs can affect the CPI in either an upward or downward direction depending on many factors. Most of the time, however, the effect will be to understate costs. A house that costs $1,500 per month to rent may cost $2,000 per month to own and occupy, especially when interest rates are high. An actual landlord may lower his costs by not maintaining the house to the same standards, and he also has lower net costs due to tax advantages (like depreciation) that are not available to an owner-occupant. Also, it is easy to imagine that during an inflationary recession rents may remain the same while everything from property taxes to insurance continue to climb.

These and other tricks have changed the computation dramatically. A former journalist, John Williams, still calculates the CPI according to the old rules, and reports on this and other government data on ShadowStats.com. A look at the statistics for 2001 to 2007, compared to the new official figures, shows that the new way lowers the CPI by at least 2 to 3 percentage points every year. At the beginning of 2006, for example, the government figures showed inflation for the previous year to be around 4%, while calculating it the old way shows it at just about 7%.

It seems that there is no real intent on the part of our government to define or measure anything resembling a true rate of inflation. Other intentions rule, which is to say; it is politics as usual.

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